Default-ratings discord

The Insolvency and Bankruptcy Code (IBC) turned recently turned three. It’s still a young law, but with the many twists and turns, learnings so far have been enormous. The recent Supreme Court ruling in the Essar Steel case, in particular, has been a watershed moment which lays the groundwork for better functioning of the bankruptcy code in the years to come.

But there are still many grey areas. One such important area is the discrepancy and inconsistency between the credit events and the actions of the rating agencies.

The NCLT courts, under the IBC, have issued over 10,000 orders on insolvency and bankruptcy cases. Default in payment precedes court-ordered insolvency resolution, usually by several months. The definition of default is best captured by the phrase “one rupee, one day”, ie, a payment which is one rupee short or delayed by one day, constitutes a default. In practice though, the term default is debatable.

But there is no ambiguity in default once a court rules on the matter and orders the insolvency resolution process to proceed. There can be no ambiguity when the court orders the appointment of an insolvency resolution professional to head the company, or when the board of the company is replaced by a committee of creditors.

A perusal of many cases shows that even when a plea is admitted in the NCLT, and the corporate insolvency resolution process (CIRP) begins, many corporate debtors continue to receive non-default ratings. For example, in the case of Agri Best India Ltd, CARE Ratings retained a CARE B+/A4 rating on the debtor even after the commencement of the CIRP. These are not isolated instances. In a separate case, even CRISIL retained the CRISIL B+ rating on Amazon Enterprises following the NCLT order of CIRP. There are over 100 cases across credit rating agencies that fall in this category (for more examples, see the Tables below).

Improper credit ratings could entail risks to players in the financial system. For instance, a lender or investor might continue to mark assets incorrectly based on the non-default rating. Suppliers and the public at large, who engage with insolvent entities, are also at risk.

The ambiguity in regulatory guidelines is a reason for grey areas. A recent judgement by the securities appellate tribunal says that there is “No Regulation or Circular … to indicate that whenever a default is made by a Company the CRA is required to automatically downgrade the Company to default”.

Several articles in the media have reported alleged irregularities and fraud in the recent cases of IL&FS and DHFL. An additional cause is the disconnect between the various silos of data. Data on credit ratings, judicial orders, company financials and declarations exist in different sources, which are not inter-linked. The need of the hour is technology that can tie together the data in the different silos. Given the technology advances in big data and analytics, there exist solutions which can bring together such large disparate data sets. However, economics does not favour technology. It is more economical to pay the paltry penalties imposed by regulators than procure and implement technology solutions.

The Finance Minister has recently proposed amendments to the IBC. It’s imperative to plug these loopholes, and the regulators and the rating agencies should look into this with urgency. Adoption of technology towards the early detection of default is essential.

The writer is a consultant in finance and technology

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